Arbor Capital

Q1 2019

February 22, 2019 by Arbor Capital

Equity Market /General Economic Commentary

The US economy is still the most robust and innovative economy in the world. Pockets of South Korea, Taiwan and Israel could probably make legitimate claims, but they are tiny in comparison and won’t move the needle globally in ways the US can.

Europe will continue to be a mess politically and economically. Major structural changes are needed but will be resisted. The UK equity markets will become a huge opportunity at some point, the pound sterling has been down relative to the euro over the last 3 years and the UK markets should rebound once Brexit is done, either hard or soft (March 29, 2019). At the end of the day, it will be less of an issue to the UK and EU economies, contrary to the news flow which makes everything a crisis. If anything, it is a time for the EU and UK to take stock and examine international relationships and truly reflect on reasons for the vote.

The US China trade reboot is overdue and necessary but feels like it is a bigger issue then it really is (sound familiar). We will continue to trade with them, they will continue to be a murky player, maybe just less murky.

The Fed’s continued unwinding of the balance sheet is still the #1 issue facing the US. If it continues in an orderly manner, things may just end up being fine. As for rates, the US gov’t can’t afford high interest rates, we just have too much national debt and an average interest rate at 5-6% or higher would eat up the budget.

The Fed’s actions during the last financial crisis show a willingness to load up and do anything, for better or worse. That is a very large adversary if bond vigilantes ever wanted to challenge it. I think they are and should be intimidated by that and wouldn’t ever target the US when there are far more ripe opportunities to exploit.

Fixed Income/Bonds Commentary

Now that we can pull up a chart on virtually any fixed income asset class and set a trailing stop on our fixed income ETF of the day via our Schwab, ETRADE, or Tradestation app we should expect the speed of market moves in bonds to resemble that of equities more than that of historically slower moving bond markets. Bond markets historically needed a crisis situation to incur the type of volatility that we saw in the last quarter of 2018; there was no crisis, only a changing in the narrative of the “expert” opinion of the direction of rates going forward. This was certainly evidenced in Q4 2018 and prices are very quickly rebounding from the lows put in during the quarter. Yields are much improved, and credit remains strong. The narrative around interest rates has done a complete 180 and we have been content to leave the positioning of the Princeps portfolios as they are even if we adjust some of the underlying holdings.

Default rates in municipal bonds continue to be less than 2% and if we eliminate some of the obvious trouble spots that number falls to near zero. Diminished supply issuance should continue to support prices even in the face of rising rates; if rates rise. Municipalities are in a much better position for the most part than they were in the last tightening cycle. Munis are slightly negatively correlated to equities and act as a good diversifier. Investors should be comfortable in allocating to municipal bonds over taxable equivalent securities as the relative returns continue to be favorable towards municipal bonds.

REIT Commentary

Unless something systemic takes down all broader equity markets, there is reason to believe REITs can outperform the broader equity markets in 2019 and perhaps 2020. The prime positive contributors to Arbor’s REIT portfolio in 2018 was the 20% weighting to health care. The other top contributor was cell towers. Though small weightings in the index, manufactured homes and net leases performed well, which Arbor did not have exposure to in 2018. Hotels and shopping centers subsectors were the worst performers in 2018, which we avoided. REITs have been afforded a new tax preference, under the Tax Cuts and Jobs Act of 2017, Section 199A, qualified REIT dividends are eligible for a 20% deduction. This may also draw some additional attention to this space that has lagged the broader markets in recent years.